By Tiernan Ray

Shares of Netflix (NFLX) are down $15.43, or almost 5%, at $322.77, on a mix of negative news flow and lukewarm Street analysis.

On the news front, the stock was not helped by a ruling yesterday by a federal appellate court stating that it and other sites “may have to pay tolls to broadband providers to ensure quality service,” as related by Amol Sharma. The ruling was a reversal of the Federal Communications Commission’s decision on Net Neutrality.

Bernstein Research’s Carlos Kirjner, who has an Underperform rating on Netflix stock, this morning wrote that although many large Internet companies will end up finding a way to work things out with cable and telco firms, Netflix may not have that option because it is more of a threat to incumbents:

The impact on Netflix is a possible exception because it uses the cable MSO infrastructure to deliver a service over broadband that can be seen as a competitor or a substitute to cable’s video business. As such, if there is one Internet company whose growth and success could trigger the MSOs to take some type of discriminatory action, we think that is Netflix2. The reversal of the Order may be seen as an improvement in the overall regulatory environment by the MSOs and embolden them to take steps that they could have already taken before the Court’s decision, e.g., implementing usage based pricing. In other words, even if we take the most extreme example of the Internet company that depends most heavily on broadband infrastructure (Netflix), the impact of the Court’s decision on the risk it faces from incumbent behaviour is marginal.

Also today, Nomura Equity Research’s Anthony DiClemente, who was formerly with Barclays, kicked off coverage of several stocks today, including Netflix, whose stock he assigns a Neutral rating and a $360 price target, writing “We believe Street models already forecast healthy expectations for subscriber growth; while we are positive on original content and cable box integration, we do not believe these are material subscriber acquisition channels.”

The company’s investment in original programming, such as “House of Cards,” is important, but unlike to lead to a major increase in subscriber numbers, he thinks:

We don’t believe Originals will drive a step-function change in subscribers in excess of current expectations. First, Originals remain less than 10% of Netflix’s content spend. Second, Netflix has already had solid success building its domestic subscribers (its 2013 share price performance reflects this success), with more subscribers in the U.S. than HBO or Showtime, comparables which already have network schedules replete with original content. Therefore, we are modeling 2014E year-end domestic streaming subscribers of 38.5 million, implying 5.4 million net adds this year, followed by a three-year CAGR (2014–16E) of roughly 11%. We believe this is both a healthy expectation and roughly in line with Street estimates. We think Netflix may be prone to a content “slump” like any other programmer; when this occurs, it should give investors a better entry point to buy the stock.

Nor is integration with cable TV going to have a dramatic result given that the company is already past HBO’s total subscriber count:

Netflix believes the integration of search and suggestions between broadband and cable improves the customer experience and is a win-win for both Netflix and distributors. As such, Netflix is in discussions with many of the MVPDs for placement of a Netflix app on a cable TV box. Last quarter, Netflix launched on the set-top box of Virgin Media, the UK’s leading cable company. It is possible that Netflix’s app will eventually also reside on an interface like the Comcast X1 […] But, once again, given that Netflix already has more subscribers than HBO or Showtime in the U.S. – both of which already have MVPD distribution – we do not believe upside in subscribers from a cable deal may be as powerful as consensus subscriber estimates imply. We believe integration with the cable box expands Netflix’s ubiquity and improves customer satisfaction and thus retention, but probably is not a material new subscriber acquisition channel.

Bottom line, the stock already reflects a healthy premium to HBO:

An important question: is Netflix valued appropriately? The market currently believes Netflix is worth 50–60% more than HBO (within TWX) and more than double Showtime (within CBS). As a multiple, we believe most investors value HBO at a 2015E EV/EBITDA of 9–10x, whereas Netflix trades at roughly double that multiple.

On the positive side MKM Partners’s Rob Sanderson, who has a Buy rating on Netflix shares, today raised his price target to $440 from $370, writing that he thinks average revenue per subscriber (ARPU) will be higher than he’d initially thought: “We now incorporate some pricing power in the out-years of our earnings power scenarios. We assume domestic ARPU of $9 per mo. and int’l ARPU of $8.50 in our 6-8 yr outlook (from $8 previously for both).”

Netflix remains one of his “top picks” for 2014, given prospects for a very large subscription business worldwide:

We think NFLX is in by far the best position to grow a very large, global subscription business in this emerging opportunity. The company has the lion’s share of know-how, scale advantages over other OTT providers and the most actual data on viewing behavior of any provider of video services across any platform. The base of roughly 40mn paying subscribers globally is just the beginning. We think this business will scale to 150-175mn global subscribers over time.

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